In the beginning of 2018, MiFID II entered into force and became a reality for banks, financial intermediaries, distributors, trading venues and manufacturers of financial products. From an EU distribution angle, while AIFMD has changed the placement rules in the EU for AIFs, MiFID II adjusts the distribution dynamics for all financial instruments in terms of distribution economics and product information. This article digs into the nature of those changes.
The changes in distribution economics
The main driver of the expected changes on distribution is the new regime on inducements. MiFID II bans the possibility to receive third party inducements in case of portfolio management and independent advice. It also limits this possibility when the distributor is providing non-independent advice or execution-only services.
In Europe, two Member States (i.e. the United Kingdom and the Netherlands) have introduced restrictions with respect to inducements. MiFID II will enhance these national regimes; the EU won’t be directly involved in that matter however. The current expectation is that inducements will remain in the retail market distribution and some segments of the advisory market.
How changes to the inducement regime impact investment firms
Changes to the regime on inducements are likely to have a significant impact on the service mix and product shelves of investment firms. Firms will no longer be able to “neutralise” the costs of creating and maintaining their products shelves with retrocessions. It will lead them to re-assess their service offering and the client segments they wish to focus on, so they find new sources of revenue.
Investment firms may consider the following aspects:
- Re-assessment of their service offering and the scope of products offered per client segment. The current ‘open-architecture’ models are also likely to put pressure for some client segments not able to afford a reasonable level of advisory fee.
- Re-design of share classes to enable distributors to target different client segments with ‘loaded’ or ‘clean’ share classes in accordance to the MiFID II restrictions per service level.
- Introduction of new fees by intermediaries and platforms to compensate the decrease or disappearance of inducements (i.e. trailer fees).
- VAT applied to most service fees introduced by the distributors to compensate the inducements.
There are two sides of the economics around distribution. On one hand, product manufacturers (i.e. asset managers) are likely to spend less trailer fees; on the other hand, they are exposed to additional fees to access sales channels (i.e. platform fees).
The rules around product governance
If the changes to the inducements regime are an important basis to re-assess both the service mix and the product shelves, so are the rules around product governance. They will affect both MiFID firms in their role of manufacturers and/or distributors, non-MIFID firms – asset managers and none-EU firms – as related parties are required to provide the necessary data/information.
Products manufacturers will have to provide to all EU distribution partners (i.e. B2B) the following key information:
- Target market, at a “sufficient granular level” to avoid the inclusion of investors the product isn’t compatible with.
- Cost disclosure, including the ongoing charges/total expense ratio as existing, but enhanced through the inclusion of ‘hidden’ costs, such as transaction costs at portfolio level.
Product manufacturers will have to ensure that the product information on the target market is available for all products (retail and institutional) to all EU distribution partners. It can be either via product information providers or via direct interfaces with the respective partners. The European MiFID Template (EMT), complementary to the PRIIPs regulation, defines the format of disclosure. At the same time, it obliges every packaged retail product manufacturer to produce a PRIIPs available to EU distributors.
What we think
MiFID II framework introduces a wide and diverse range of new requirements. They will result in fundamental shifts for all stakeholders. Impacts on processes, documentation, organisation and IT systems are considerable. To comply with MiFID II it’s not enough to adapt and be well equipped for the new environment. Firms have to go beyond this compliance exercise. They have to engage in a strategic reflection on their own services and products and/or on their distribution set-up.